Nobel Laureate in Economics Milton Friedman‘s admonition that:
“…nobody takes care of somebody else’s property as well as he takes care of his own.”
was voiced in the context of the deleterious effects of overwrought government intrusion and control. In other words, free market participants who have a “stake in the game” are superior custodians of property rights.
In business, Dr. Friedman’s admonition gets to the heart of what motivates a worker to serve in the best interests of the enterprise: if a worker’s sense of belonging is alien to the fortunes of the enterprise the business runs the risk of serving the marketplace with, at best, an indifferent work force or, at worse, a hostile one.
So the challenge becomes how does business align the interests of employees – especially employee members of the rank and file who might feel most distant from the organization’s mission objective – with those of the enterprise such that their behavior is consonant with that of executive management as well as that of shareholders?
IT ISN’T ALL ABOUT MONEY
If money were the answer we would find the best performers in those corporations best able to shower their employees with lavish salaries and perquisites. Unfortunately, no correlation has ever been found between the amount of pay and job satisfaction or engagement.
In fact, it might be argued that a strict reliance on pay as a motivator might nullify potentially powerful intrinsic job motivators such as a desire to learn new skills, to achieve, and to belong.
Fundamentally, executive management must explicitly stipulate the organization’s goals and expectations to all of its members and to seek their accord. Workforce recruitment strategies are of signal importance in this context as there is plenty of evidence to suggest that the more stable, conscientious, patient, and agreeable the worker is the more he is apt to enjoy his job. Also, mapping the components of a job to the individual performer ensures the worker’s interests and skills correspond properly to the tasks to which he has been assigned.
Finally, a key intangible driving employee job satisfaction and performance has to do with the leadership qualities of the management team. An uninspirational leadership team unwilling or unable to empower its employees to, in effect, make mistakes can erode the job satisfaction and consequent performance of its employee workforce.
Left unresolved, misaligned goals lead to conflicts of interest where each party behaves in its own self-interest. The upshot of this behavior, if not stemmed, can become internally dysfunctional to the organization and easily telegraphed to the marketplace.
OWNERSHIP CAN BE A POWERFUL INCENTIVE
Once goals and expectations are aligned the issue turns to how best to financially incent workers so that they serve the business as if it were their own. Some of the more common programs are as follows:
- The incentive of choice especially for development stage or start-up companies, and companies challenged with the need to traverse difficult inflection points has historically been the stock option incentive program. A stock option program typically provides the employee recipient an opportunity – an option – to purchase shares at a set or strike price. Recipients awarded options are then allowed to acquire – or exercise – shares after a vesting period which can usually range from three to five years. The incentive, of course, is to have an opportunity to purchase stock given the potential uptick in value between the grant price and exercise price. For companies, the benefit that accrues from offering a stock option program is to induce a long term view of the business on the part of the employee. Further, if the enterprise is cash-strapped – as most young companies are – by conserving cash that might have gone to salaries.
- Another common stock incentive program is the restricted stock program. Under this program, the company agrees to grant the employee shares of stock at the end of a vesting period, and subject to the recipient’s specific job performance or achievements. Once the shares are awarded the employee become a bona fide shareholder.
- Employee stock ownership plans (ESOP’s) have become popular as a way of rewarding management and rank and file employees with an ownership stake when a business owner is ready to exit the business and perhaps retire. These programs are not, strictly speaking, employee incentive programs as much as they are employee benefit plans as employees receive their shares as a contribution and not as a purchase. In addition, the ESOP’s management trust is obligated to purchase an employee’s shares at a stipulated price upon termination of employment. This feature of the ESOP casts a pall over the program as stock repurchase obligations can compete with other capital needs of the business potentially limiting its grown. The ESOP also has to contend with the administrative, valuation, trustee, and legal costs of managing what is administratively a complex plan.
EQUITY INCENTIVE PROGRAMS WITHOUT EQUITY
“Ownership” incentive programs that do not involve the granting of equity can be equally powerful in motivating a dedicated workforce. Two of these programs are noteworthy:
- A program that doesn’t get the attention it merits but which I have used extensively and with great success is the stock appreciation rights (SAR’s) program. This program allows employees to participate in the benefits of ownership without actually being in possession of equity shares. As with the more conventional stock option program, recipients are awarded a certain number of SARs whose individual unit value mirrors a share of actual stock and which vests over a stipulated time frame. At the end of the vesting period, the recipient exercises his SARs and receives a cash payment equal to the difference in value between the grant price and the exercise price. The benefit for the company granting SARS is that while employees are given the opportunity to behave as owners the company does not have to carve out or dilute its equity base.
- Phantom stock programs are similar to SAR programs in that they are used to award a cash payment given any number of formulas but which are usually based on the growth in value of the company’s stock. Participants in a phantom stock program are granted units as part of an agreement with the company but there is no exercise required of the granted units. The company simply agrees to pay an amount equal to the terms of the agreement.
“OWNERSHIP IS A COMMITMENT OF THE HEAD, HEART, AND HANDS TO FIX THE PROBLEM…”
John G. Miller‘s dictum ends with the phrase:
“…and never again to fix blame.”
It was in that spirit that equity-based compensation programs came into being. Equity-based programs help align the employee’s financial interests with those of the business. Further, these programs allow the corporation to bind its employee culture around a central mission. Clearly, the company offering the stock incentive program benefits from having a dedicated and long-lived workforce. As owners, equity recipients must consider the consequence of their actions, or inactions, on the fortunes of the business. For companies, no reliable substitute has ever been found that is superior to equity-based incentives for attracting, motivating, and
retaining top talent.